Chapter 12: Statement of Cash FlowsBalance sheet, income statement, and retained earnings statement provide little insight on cash flow Statement of Cash FlowReports:1. Cash receipts2. Cash Payments3. Net change in cash resulting from operating, investing, financing activities Helps investors, creditors, and other assess:1. The entity’s ability to generate future cash flows2. The entity’s ability to pay dividends and meet obligations3. The reason for differences between net income and net cash provided (used) by operating activities4. The cash investing and financing transactions during the period ClassificationsOperating activities: (most important; satisfies going concern)· Cash effects of transactions that create revenue and expenses.Investing activities:· Cash transactions that involve purchase/disposal of investments/property, plant, and equipment.· Lending money and collecting loansFinancing activities:· Obtaining cash from issuing debt and repaying amounts borrowed· Obtaining cash from stockholder, repurchasing shares, and paying dividends. Types of Cash inflows and outflows (Only included the tricky flows)Operating: always involves income statement items Cash inflows:· From interest received and dividends receivedInvesting activities: changes in investments and long-term assets Cash inflows:· From sale of investments in debt or equity securities of other entities· From collection of principal on loans to other entitiesCash outflows:· To purchase investments in debt or equity securities of other entitiesFinancing activities: changes in long-term liabilities and stockholders’ equity Cash inflows:· From issuance of debt (bonds and notes)Cash outflows:· To redeem long-term debt or reacquire capital stock (treasury stock)Noncash Activities (no cash is used)1. Direct issuance of common stock to purchase assets2. Conversion of bonds into common stock3. Direct issuance of debt to purchases assets4. Exchange of plant assetsRecording Noncash: companies do not report noncash financing and investing activities in statement of cash flow.· Report in either separate schedule at the bottom or separate note or supplementary schedule to financial statement.Satisfies full disclosure principle Preparing Statement of Cash Flows:(Must adjust effects of the use of accrual accounting to determine cash flows)1. Not prepared from adjusted trial balance2. Requires detailed info from two point in timeThree sources:· Comparative balance sheet· Income statement· Additional Information Indirect and Direct Method(must convert net income from an accrual basis to a cash basis)Two methods: Both have same “net cash provided by opt. act.” Differ in how theyget to the amount.1. Indirect: adjust income for items that do not affect cash to find net opt. act.a. Easier and less costly to prepareb. Focuses on difference between net income/cash flow from opt. act.c. 99% of companies use this method2. Direct Method: show operating cash receipts and paymentsa. FASB has expressed a preference for the direct method. Indirect method Cash flow from operating activitiesNoncash charges· Depreciation (and patent amortization) expense: reduces net income but not cash; must be added back to net incomeGains and Losses· Loss on sale of equipment: must eliminate gains/losses by subtracting/adding back. (ex: if you have a loss add it back to net cash)Assets/Liabilities· Changes in current assets: inverse· Changes in current liabilities: Add to net income increases in current liabilities and vice versaFree Cash Flow=Cash Provided by operations-capital expenditures-cash dividends Chapter 13Sustainable income: Net income adjusted for irregular items.· Most likely to be income obtained in the future Irregular Items: (“Let the tax follow the income or loss”)1. Discounted Operations: disposal of a significant component of a business2. Extraordinary Items: event that has never happened and will never happen again.Comprehensive IncomeFASB requires companies to report net income and comprehensive income.· Comprehensive income includes all changes in stockholders’ equity not resulting from investments by stockholder and distribution to stockholders.Unrealized Loss:1. Trading Security: reported in other expenses and losses section2. Available-for-sale securities: not purchased for trading purposes; reported in “othercomprehensive income”Two purposes:1. Reduces volatility of net income due to fluctuations in fair value2. Informs financial statement users of gain/loss if company sold the security at fair value.Comparative Analysis1. Intracompany basis: compare a company to itself2. Intercompany basis: compare a company to its competitor3. Industry averages: compare a company to the average of the companies in its industry Three basic tools in financial analysis1. Horizontal analysis (trend analysis): compared over time; expressed as a percentage.Percentage increases/decreases relative to the base-period amount (Change since Base Period=current amt-base amt/base amt)Current year sales as a percentage of the base year (Current Results in Relation to Base Period=Current-year amount/base-year amount) 2. Vertical Analysis: expresses each item in a financial statement as a percentage of a base amount. (Ex: Assets/Total Assets)a. For income statement net sales is the base 3. Ratio analysis: Relational analysis among statements; allows comparing various sized entities to one another (“right sizing”). Ratio AnalysisLiquidity Ratios: measures short-term ability to pay obligations and produce cash. (short-term creditors care about this)Solvency Ratios: measure ability to survive over a long time (long-term creditors and stockholders care about this)Profitability Ratios: Measures operating success of an enterprise for a given period of time (Everybody care; income affects ability to obtain debt and equity financing, its liquidity position, and its ability to